Are Robust Financials Driving The Recent Rally In WEG S.A.'s (BVMF:WEGE3) Stock?

WEG's (BVMF:WEGE3) stock is up by a considerable 33% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study WEG's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for WEG

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for WEG is:

30% = R$6.0b ÷ R$20b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every R$1 worth of shareholders' equity, the company generated R$0.30 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of WEG's Earnings Growth And 30% ROE

Firstly, we acknowledge that WEG has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 8.7% also doesn't go unnoticed by us. Under the circumstances, WEG's considerable five year net income growth of 27% was to be expected.

As a next step, we compared WEG's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 17%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about WEG's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is WEG Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 51% (implying that it keeps only 49% of profits) for WEG suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Additionally, WEG has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 52%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 31%.

Summary

On the whole, we feel that WEG's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.